Value and Price in Neoclassical Economics
Around the 1870s, William Stanley Jevons, Carl Menger and Leon Walras all took the classical political economy Ricardian method of determining rent (as, in the case of the “extensive margin”, the difference between the productivity of a given plot of land and the productivity of the worst equal-size plot in cultivation, or, more generally in the case of the “intensive margin”, as the difference in the productivities of plots as more labour and complementary inputs are applied to them) and applied it to the determination of the prices of other “factors of production” - hence the terminology “neoclassical”.
In so doing, they developed a distinct alternative to the classical approach, in which the wage, for example, depends not on the conditions of the supply and reproduction of the labour force, but on its short-term scarcity. Instead of starting with the problem of the determination of long-period prices of production (and then considering the market price fluctuations around them), technological change and the reproduction of the economy, the neoclassical starting point was the problem of finding equilibrium prices with given stocks of input resources such as land, labour, and means of production. Consequently, the term “capital” came to have a generally narrower reference than in classical political economy, meaning either the sum of money invested in non-labour means of production or the physical inputs so purchased, depending on the context. Rather than considering the turbulent mobility of labour, on the one hand, and capital as invested money, on the other, as in classical political economy, the neoclassical vision was based on a given state of allocation of resources, in which, for any given technology, endowments and preferences, all firms and households optimized on the basis of parametric prices and all markets cleared. Instead of contingent demand and supply fluctuations causing actual market prices to fluctuate around their long period equilibrium, in the neoclassical approach those demand and supply fluctuations are understood as being themselves the immediate determinants of equilibrium prices.
Underlying demand are the choices of the utility-maximizing consumer households, but choices restricted by the equilibrium prices and incomes, and supply is in the first instance restricted to the actions of the same consumer households in selling less wanted endowments in order to purchase a more desired bundle of commodities. Hence the neoclassical initial focus was on an exchange economy, in which the individual as consumer was sovereign. The subsequent addition to the picture of producing firms that passively choose input and output levels to minimize costs and maximize profit at equilibrium prices is something of an afterthought, requiring no fundamental change in the theory of determination of equilibrium prices (as long as technology is assumed to be characterized by non-increasing returns).From the neoclassical point of view, the classical political economy distinctions among the categories of value, price of production, and market price are subsumed under the general category of equilibrium price. Once equilibrium prices are explained, there is no theoretical role for the concept of value in the neoclassical framework. As a result neoclassical economists tend to use the term “value” either in the sense of the value of a bundle of commodities (the sum of the quantities of each commodity in the bundle multiplied by the corresponding price), or simply as a synonym for “price”.
By the 1950s, Debreu (1959) could call his study of neoclassical general equilibrium theory The Theory of Value, and Koopmans could define “value theory” as “the theory of prices as guides to allocation of resources and of the relation of these prices to the technology” (Koopmans 1957: 148). The theory of value has no content for neoclassical economics other than as an ontology of consumer sovereignty with exogenous preferences, and the theory of price becomes an atemporal theory of market-clearing equilibrium prices.
Both internal and external critics of the neoclassical framework have noted several lacunae in the neoclassical theory of prices.
If all agents are price-takers, it is not obvious how any price is ever changed. The institutions of households and firms are emptied of any substantive sociological content (as indeed are markets) and become purely mathematical abstractions in the form of utility and production functions. Despite heroic efforts of mathematical economists, the uniqueness and stability of a general equilibrium system of market-clearing prices cannot be assured without restrictive special assumptions. Trading at disequilibrium prices and the resulting path-dependence of final allocations has not been addressed effectively. The attempt to apply the theory of market-clearing equilibrium prices to produced means of production gives rise to paradoxes discovered by Piero Sraffa, including the phenomena of “reverse capital deepening” (a fall in the value of capital at lower profit rates), and “re-switching of techniques” (cost-minimizing firms adopting the same technique of production at high and low profit rates and a different technique for intermediate profit rates), which are incompatible with the notion that the profit rate is an index of the scarcity of capital. The attempts of neoclassical economics to circumvent these problems by generalizing the framework from atemporal equilibrium to intertemporal equilibrium have foundered on problems of incompleteness of markets, the formation of expectations, the constant introduction of novel commodities as a result of technological change and the exogeneity and stability of preferences over time. (On these points see Kirman 2006; Foley 2010; and references cited therein.)As a result, the neoclassical theory of market-clearing equilibrium resource allocation has become increasingly disconnected from economic reality. For example, in the later years of the twentieth century the existence of unemployment was attributed by many neoclassical economists to the intertemporal substitution of leisure for labour by forward-looking perfectly rational workers, a logically necessary implication of the presumption of market-clearing prices in the labour market, but a conclusion that struck many others as absurd.